ARTHUR LEVITT'S HARDBALL AT THE SEC

The SEC chairman is stepping on toes. Is that really such a bad thing?

Arthur Levitt Jr., 66, is having the time of his life. In four years as chairman of the Securities & Exchange Commission, Levitt has accomplished a great deal, from cleaning up unsavory behavior in the over-the-counter market and cracking down on rogue brokers to curtailing political favoritism practices in the municipal securities business. There's little question that he has become one of the most powerful and effective SEC chairmen in memory. Even though he founded what is now Smith Barney Inc., chaired the American Stock Exchange for 12 years, and did stints as an entrepreneur, publisher, and cattle trader, Levitt declares: ''I've never had a job I've enjoyed as much as this.''

These days, though, he's getting a lot of grief in the process. By pushing aggressively on many fronts, he has inevitably made enemies among the bankers, brokers, accountants, and stock- exchange officials the SEC regulates or oversees. A backlash is building not only on Wall Street but also on Capital Hill and among some academicians, who complain about what they view as Levitt's heavy-handed regulatory style. ''His methods are much too crude,'' says a former SEC commissioner who declined to be quoted by name. ''He goes in with a bludgeon when the situation calls for a scalpel.''

Levitt's allies point out there is always a necessary price for effective regulation. They argue if Levitt is sometimes heavy-handed, that's certainly better than being captured by the special interests that dominate other federal agencies. Says Daniel P. Tully, a former Merrill Lynch & Co. chairman: ''Those who say he's dictatorial don't understand that Arthur is doing what's best for our industry.'' In many ways, Levitt is simply the victim of his own success.

Levitt concedes that he has been overbearing at times. But as the financial markets' top cop he considers his actions proper. ''I want to be known as the investors' chairman,'' he declares.

BITTER CRITICS. Much of the criticism he faces is a matter of style. But some is more substantive. Though Levitt has strived to improve the workings of the stock exchanges, his critics claim he has subverted the exchanges' self-regulatory structure by pushing onto governing boards his far-flung network of former employees, politicians, and SEC colleagues--some say cronies.

In trying to cut through red tape, say critics, he operates in a somewhat back-channel manner, such as pressuring the private sector's Financial Accounting Standards Board to adopt controversial new rules for derivatives. In so doing, Levitt escaped the arduous federal rulemaking process as well as the congressional scrutiny that goes with it. And because he publicly discourages industry leaders from taking complaints to Congress, critics say he's abusing his authority by denying redress.

Levitt, however, bristles at suggestions he interfered inappropriately in any exchange's internal affairs or that he ever dictated who should sit on an organization's board. The derivatives rule, for which Levitt fought hard, is just one example of how he sticks his neck out daily to give investors more information and make markets safer, he asserts. Yet ''a day doesn't go by without someone wanting to string me up.''

That's exactly what some past and present board members of the National Association of Securities Dealers would like to do. Perhaps Levitt's greatest victory was last year's successful remaking of the NASDAQ, which the SEC concluded had failed to police market makers engaging in numerous practices that harmed smaller competitors and increased investors' costs. The NASD has since separated regulatory and trading operations and each now has its own board and staff.

But several board members are still bitter over the way Levitt handled the matter. When the SEC completed its probe last summer, NASD had already adopted many governance and other changes suggested by a special committee led by former Senator Warren B. Rudman and approved by Levitt. When the SEC's settlement offer was unveiled, NASD sources say, the board was aghast at the wide range of changes demanded, especially one stipulating three years of oversight by an outside consultant. Says one director: ''We discussed resigning en masse.''

The deal was agreed to because the alternative would have been years of litigation. Once it was signed, board member Alphonse A. Sommer Jr., a former SEC commissioner and friend of Levitt's, sent him a note saying: ''Yesterday was the darkest day in the life of the SEC.''

MICROMANAGEMENT. In retrospect, Levitt says he understands ''why they might've felt abandoned'' at the last minute. ''But our investigation was coming up with information that required us to go farther than what Rudman was recommending.'' William R. McLucas, SEC enforcement director, defends the settlement offer. ''You don't get stuff done in this town by being a shrinking violet,'' he says.

There was no shrinking from punishing the Philadelphia Stock Exchange, the nation's oldest bourse but also one of its most endangered. Just as the NASD case ended, the SEC opened one against PHLX, whose chairman, Vincent J. Casella, would soon resign in the wake of an alleged conflict of interest involving his investment in a company that had won a major contract to update the exchange's trading technology.

Levitt responded with moves that some believe threatened the exchange's independence. And Levitt's actions raise serious questions about the future of self-regulatory organizations, or SROs, as all exchanges are called. By law, SROs make their own rules, but with SEC oversight.

First, Levitt demanded that the exchange restructure its board so half its members represent the public interest. He even provided a list of acceptable names, many of whom now sit on the board after getting calls from Levitt. When the PHLX board told Levitt it had chosen Leopold Korins, a former chairman of the Pacific Exchange, to be its new chairman and chief executive, Levitt asked to interview Korins before an offer was made.

Such micromanagement of personnel matters is justified at a troubled SRO, Levitt argues, but some question whether regulators should be in on the selection of people they oversee. Not only might it defeat the purpose of self-regulation and call into question the authority of boards, but it could also cause future problems. SEC officials, for example, might be reluctant to challenge former colleagues and bosses. ''It concerns me if one person tries to increase his span of control over something as important as the financial markets,'' says Junius W. Peake, a finance professor at the University of Northern Colorado and a former NASD director. ''Anything that undermines the system of checks and balances is dangerous.''

Some suspect a hidden agenda. PHLX sources point to Peter R. Kellogg, CEO at Spear Leeds & Kellogg in New York. While serving on a special committee to review the exchange's corporate governance, they say, Kellogg offered to act as a liaison in possible merger talks with the American Stock Exchange, one of Philadelphia's fiercest competitors in the options trading business. Kellogg, whose company has a major Amex presence, did not return BUSINESS WEEK phone calls.

The offer was refused, as were several previous attempts by Amex to forge alliances with Philadelphia, including one Levitt led himself in 1982 when he was head of the Amex. Not only would a merger eliminate a major competitor, but it also would boost Amex' market share against the Chicago Board Options Exchange, the largest of all the options exchanges.

Levitt does not dispute that he sought to open merger talks with Philadelphia in 1982. But he denies that he had any such intention as SEC chairman and adds that he would consider it a failure if any of the regional bourses disappeared on his watch.

BACKED DOWN. Levitt's crusade for more public representation on boards was apparent as well last year when he sought to remake the Financial Accounting Foundation, which oversees the FASB--which, in turn, sets the accounting standards that the SEC relies on for public company filings. The commission long ago delegated to FASB its authority to set accounting rules, in the belief that independent, private-sector standards would more easily win acceptance in the industry. Levitt wanted a majority of FAF's trustees to have no corporate, accounting, or securities industry ties in the belief that such people do not represent the public interest. Levitt admits he even threatened to take over the accounting standards process if FAF didn't act quickly.

But he backed down in the face of criticism. Senator Phil Gramm (R-Tex.), chairman of the Senate Banking securities subcommittee, told Levitt his proposals for public representatives ''threaten to make a farce'' of the process by which accountants develop standards. ''It was heavy-handed, and it was a mistake,'' Levitt admits.

Levitt may have lost that battle, but he appears to be winning the war. Six out of 15 trustees, whom Levitt saw as beholden to special interests, have departed or will at yearend. And with the FASB's Sept. 2 release of a much-debated derivatives accounting rule--which is to take effect in January, 1999, if the FASB gives final approval after a 45-day comment period--the SEC chairman can declare victory in a battle of monumental proportions.

The new rule requires companies to mark-to-market, or declare the fair value of any derivatives they hold, and to reflect that value on their balance sheets. Because the rule could make reported earnings more volatile (page 54), a number of large banks and corporations oppose it and view Levitt's behind-the-scenes maneuvers with great suspicion. Says the controller at a top money-center bank: ''This is a sham. If Arthur Levitt wants to take over the accounting rules, let him do it in the open.''

In truth, Levitt outfoxed them. He recruited people whose views were similar to his and neutralized opponents. He personally sought out former Federal Reserve governor Manuel H. Johnson Jr. to chair the foundation, giving him a worthy counterweight to Fed Chairman Alan Greenspan, who opposes the rule. Levitt, says Johnson, ''insisted on outside members and saw me as someone who was not from a corporation or Wall Street, so he asked if I would serve.'' Levitt, in fact, has played a role in filling dozens of exchange, advisory, and regulatory board positions, including NASD Chairman Frank G. Zarb, who once worked for Levitt on Wall Street. After 30 years in the industry, ''it's likely anyone who takes a top job knows me. That's a good thing,'' he suggests.

Maybe so, unless people think he's stacking boards to get a preordained outcome. That's what Senate securities subcommittee chairman Gramm is beginning to think about the derivatives rule, congressional sources say. Gramm is likely to hold hearings this fall on the FASB rule. And any loss of industry support might make it harder for Levitt to tackle a wide range of issues on his plate, including a campaign against fraudulent penny-stock sales.

Unlike most regulators from the private sector, Levitt has figured out how to get things accomplished in Washington. ''I'm a very determined person, and I have a limited time here,'' he explains. He hasn't decided if he'll ask President Clinton to name him to another five-year term next June. On the evidence so far, though, his legacy will be that of a chairman who was willing to aggressively pursue reform as he saw it--even if it meant creating some ill will in the process.